More Than Five Means…..?

The phrase “more than five full time employees” is used in the Income Tax Act (“the Act”) mainly to establish whether an investment business is to be considered “active” for the purposes of the definitions of FAPI (foreign accrual property income) and, more commonly, for the purposes of claiming the small business deduction.

Until recently, the 1994 case of The Queen vs. Hughes & Co. Holdings Ltd. was the guiding precedent. In that case, the Tax Court interpreted the phrase to mean that all the employees considered must be full time, and there must be more than five, meaning at least six of them.

Enter the new millennium, and the interpretation has changed. In the recent case of 489599 B.C. Ltd. vs. The Queen, the Court has overturned the Hughes interpretation of the phrase, conceding that five full time employees plus one part time employee will satisfy the requirement. It all comes down to grammar, of course. The Court concluded that the word “more” modifies “than five”, and not, as Hughes suggested “full-time employees” (just play with the emphasis on different words and you’ll get the idea).

The Court goes on, however, to confirm the other principles set out in Hughes. There still must be five employees that are full time. You cannot, for example add up ten part-timers to meet the test. Nor can you allocate fractions of employees among co-owners or partners in a partnership. Each business must count its employees on its own.

At the recent Canadian Tax Foundation Conference, the CRA confirmed that it will abide by the more recent decision.

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